Economic Decision-Making with Chinese Characteristics

Daniel H. Rosen is founding partner of Rhodium Group (RHG). This article was adapted from a presentation at CSIS in late February 2014.

How governments make decisions depends on how decisively they are empowered to act. The political economy of China evolved from 1978 onwards to reflect two basic problems that were clear to China’s leading individuals at the end of the Mao era. First, that the state’s management of the economy had destroyed it and impoverished the nation relative to its neighbors; and second, the concentration of unchecked decision-making power in a single individual could be disastrous.

Therefore over the course of China’s ensuing reform period were, first, that the growth was the categorical imperative and government involvement and regulation were only permitted to the extent they did not choke off growth — even to the point of letting tens of thousands of foreigners and their firms into the hitherto autarkic Chinese economy or watching the ecology be despoiled; and second, that authority to make major political decisions was diluted across the membership of the Standing Committee of the Politburo, and even the General Secretary was beholden to his colleagues’ concurrence. Like separation of powers in ancient Athens or modern America, in Beijing the dilution of authority beyond the hands of one man was meant to guard against executive excesses, which China has confronted for millennia, Mao Zedong being only the most recent example.

And as in Greece, and here in Washington, the problem with fragmenting power — whatever the motive — is that it is prone to gridlock, which despite all the talk about China’s dynamism and ability to move faster than Western democracies has crept up and stymied decisive action over time. The structural adjustment that was evidence of policy reform after 1978 petered out by the 2000s, causing growth to stall, return on investment to falter, productivity growth to moderate, and risks to rise.

Against that backdrop, many analysts expected China’s fifth generation leaders — Xi Jinping and Li Keqiang — to be tightly constrained by vested interests and committee-reluctance to put anyone’s elite interests at risk. Instead, Xi has surprised most observers by consolidating power and decision-making authority and reasserting the government into the regulatory business in the name of long-term growth despite the short-term risk to GDP. The change to business as usual extends beyond economics to the security cone and politics.

How could we view the reform document released at last November’s Third Plenum of the Communist Party’s Central Committee through the prism of economic decision-making power?

First, as with the adjustment to the Standing Commitee’s structure at the First Plenum, the Third Plenum delivered power into Xi’s strong executive hands. Nominally, Xi’s name upstaged Premier Li’s throughout the deliverables. The premier traditionally holds the economic portfolio in reform-era China; clearly Xi holds it now. Bureaucratically, the Plenum created a new Reform Leadership Small Group with the stated purpose of taking responsibility for reform away from the National Development and Reform Commission (NDRC). The importance of Xi’s personal imprimatur for the reform agenda, combined with the enhanced power of his position, cannot be overstated. The expectation that Li Keqiang would be a weak bureaucratic operator, and that Xi would be disinterested in economics, had been principal arguments for skepticism about the economic reform outlook even less than one year ago.

Second, the Plenum results — particularly the “60 Decisions” — demonstrated the comprehensive scope of Xi’s reform intentions, and keen awareness of how the many planks interrelate. Sixty reforms is too many to make sense of, and the terms thus used to describe them are often euphemistic and opaque. In short, there are 2 takeaways in terms of substance that should be remembered: the new definition of categorical roles for government, and the specific clusters of policy actions the Plenum calls for.

First, the Plenum issued a reinvented, 7-point mission statement for government:

1. Maintain macro-economic stability (Define, implement and enforce policy that maximizes long-term welfare by reducing volatility and vulnerability to economic shocks so as to create healthy conditions for growth)

2. Strengthen and improve public services (Deliver public goods which the private sector will not provide efficiently, which optimize general warfare; including public safety and defense, a predictable and accountable legal and court system, basic healthcare, basic education, sanitation, basic water and utilities)

3. Safeguard fair competition (Define, implement and enforce pro-competitive regulations, a competition policy/anti-monopoly policy regime)

4. Strengthen oversight of the market (Define, implement and enforce regulations to ensure the efficient functioning of markets toward the objective of consumer safety and welfare)

5. Maintain market order (Maintain the balance between markets as the primary engine of economic growth and economic, social and political stability)

6. Promote sustainable development and common prosperity (Define, implement and enforce regulations to ensure sustainable ecological development of the environment in the context of economic growth; and define, implement and enforce regulations to ensure sufficient distributional equity in terms of national income and other indicators of prosperity such as access to affordable healthcare and education, and social safety nets)

7. Intervene in situations where market failure occurs (Where the allocation of goods and services by competitive markets is not efficient)

Second, separating and reorganizing the hundreds of economic commitments in the 60 Decisions produces ten clusters:
1. Regulation/Deregulation

2. Pro-competitive Policy

3. Government Redeployment and Fiscal Reform

4. State-Owned Enterprises

5. Financial Liberalization

6. Trade and Investment Opening

7. Land Market Rationalization

8. Labor and Human Capital

9. Sustainability

10. Industrial Policy and Innovation

Overall, the Plenum results present a necessary but not sufficient roadmap to economic development convergent with the interests of other economies, including the United States.

There is plenty of language in the Plenum Decisions which is less consistent with this happy story. For instance, “persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector, and continuously increase its vitality, controlling force and influence” (Decision 11). Of course, since 1978 whenever reform was introduced it always shared the stage with old language for a while, which is how China changed course without having to publicly admit old mistakes — and risk having to assign blame for them — at the same time. So the November 2013 Plenum does not surprise us in this rhetorical ambition. At the same time, other reform language asserting that the Party, not the government, is at the center, is far from transitory and should not be taken lightly.

Third, the boldness evident at the Plenum was not just rosy window dressing: concrete action is being taken, even over the brief period since November. An assessment by the government-related Beijing News in late February identified action steps having been taken on at least 31 of the 60 plenum decision points since November. On March 1, a number of other steps were implemented, including amendments to the Company Law (registration simplification and abolishment of capital requirements) and bank liquidity ratios (100% by 2018). The Shanghai Free Trade Zone initiative is attracting far more serious foreign and private interest than skeptics expected 3 months ago, with policies expanding cross-border renminbi businesses for sweeping up and pooling corporate treasury accounts and relaxing some FDI restrictions, as well as administrative reforms already in effect. Central bank activism in the interbank markets, in pursuit of better capital discipline, is greatly increased — although we are still debating the extent to which the Bank can now be proactive rather than reactive. Serious discussion about state-owned enterprise reform is brewing. IPO issuance has restarted — albeit haltingly. Another “concrete” action was the high-explosives demolition of hundreds of cement plants in north China since December.

Fourth, while the thrust of the Third Plenum decisions suggests a clear shift in the direction of market mechanisms, it is important to note that the policy schisms within market economies can loom as wide as those between market economies and more socialist models. Assuming it is correct that Xi Jinping is turning China in the direction of the market and has bureaucratic authority to impose that course correction, there remain profound differences of policy opinion in terms of what that means. On first reading, the Plenum Decisions appeared to be a clear-cut victory for the Market Liberal camp in Beijing; on closer inspection, New Left proponents are still well-represented.

Indeed, while Xi has been willing to confront political opponents like Zhou Yongkang, break with the politics of the previous leadership, and crack down on progressive voices espousing constitutionalism and separation of powers, he cannot impose orthodoxy in terms of what a market economy really is. Whether the acid test of economic success for Xi will be total factor productivity and consumer welfare the way we understand them cannot be known. If that is what it takes to assure growth, then that is what he will emphasize. But is it? Opinions vary — in Washington, in New York, and certainly still in Beijing.

Xi Jinping says China must allow market forces to play a decisive role in allocating resources and clearing supply and demand in the Chinese economy. We have already seen indications of market-oriented reform, particularly in the financial sector. At the same time, in other areas reform rhetoric is still heavier than implementation. And the direction of political and social reform — also prominent in the 60 Decisions — is even less clearly defined. Chinese decision-making in transition will continue to be marked by seeming contradictions and suggestions of hidden agendas, and a Rosetta Stone for interpreting these tangled signals will be dearly needed.

Whether decisive, market-oriented reform in fact eventuates, and when, has existential consequences for other nations, including the United States. As President Xi himself has argued, in the recent past China was unable to make economic decisions efficiently enough to serve its own welfare interests, let alone to allay the legitimate concerns of its partners; and therefore other nations have reasonable grounds to ask hard questions about how policy will be formulated and implemented in the future.

In sum, Xi Jinping has made as good a down-payment as we could hope for toward better economic policymaking. If Beijing achieves its self-described Third Plenum objectives, it will be a promising partner for efforts to deepen trade, investment and global stewardship, such as the Trans-Pacific Partnership. While it behooves us to watch carefully for evidence of whether those objectives are in fact being met, we should actively acknowledge Xi’s reform thrust by asking what we can do to help. Greater understanding of Chinese economic decision-making in transition is the key to our confidence in extending that hand.

Copyright © 2014 CSIS

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